Maximum Drawdown
Maximum Drawdown measures the largest peak-to-trough decline an investment experiences—the worst loss endured by unlucky buyers at the peak.
What You Will Learn: You'll understand how Maximum Drawdown measures the worst peak-to-trough loss an investment can experience. Learn how to use this metric to assess downside risk, set position sizes, and identify investments that protect capital during market downturns.
Definition
Maximum Drawdown measures the largest peak-to-trough decline an investment experiences over a specific period. It answers: "What's the worst loss I could have endured if I bought at the top?"
Formula
Max Drawdown = [(Trough Value - Peak Value) / Peak Value] × 100Example Calculation
Peak Value (Month 4): $108,000
Trough Value (Month 6): $92,000
Drawdown = [($92,000 - $108,000) / $108,000] × 100
Drawdown = -14.8%
An investor who bought at the absolute peak would have experienced a 14.8% decline before the investment began recovering.
Why Maximum Drawdown Matters
Worst-Case Reality
Shows actual pain endured by unlucky investors who bought at peaks
Leverage Constraints
Large drawdowns trigger margin calls and forced selling
Behavioral Test
Reveals whether you can emotionally withstand the worst period
Recovery Time
Deeper drawdowns require longer recovery—capital is dead money
Drawdown Tolerance Guide
| Range | Tolerance | Appropriate For |
|---|---|---|
| 0% to -5% | Minimal | Conservative; short-term needs |
| -5% to -15% | Moderate | Income-focused investors |
| -15% to -30% | Significant | Patient growth investors |
| -30% to -50%+ | Severe | Sophisticated, long-term holders only |
Historical Maximum Drawdowns (2000-2024)
| Property Type | Max Drawdown | Period | Recovery |
|---|---|---|---|
| MHC | -3.2% | 2007-2009 | 2011 |
| Industrial | -12.8% | 2007-2009 | 2012 |
| Self-Storage | -15.2% | 2008-2010 | 2012 |
| Multifamily | -18.5% | 2007-2009 | 2013 |
| Retail | -32.8% | 2007-2009 | Never |
| Office | -42.5% | 2007-Current | Unknown |
Stark Contrast
MHC's -3.2% maximum drawdown is less than one-tenth of office's -42.5% decline. Office investors at 2007 peak still haven't recovered—17 years later. $1M invested in office at 2007 peak is worth ~$575K today. MHC investors recovered within 4 years and have since doubled capital.
The Math of Recovery
| Drawdown | Gain Needed to Recover |
|---|---|
| -10% | +11% |
| -25% | +33% |
| -40% | +67% |
| -50% | +100% |
The Asymmetry of Loss
A 50% decline requires a 100% gain just to break even. This mathematical reality explains why preserving capital during downturns matters far more than capturing every upside move. Avoiding large drawdowns compounds wealth faster than chasing maximum gains.
Using Maximum Drawdown in Investment Decisions
- 1.Know Your Tolerance: If you'd panic-sell at -20%, don't invest in assets with -35% historical drawdowns
- 2.Position Sizing: Larger allocations to lower-drawdown assets; smaller positions in high-drawdown opportunities
- 3.Recovery Time Matters: A -20% drawdown with 2-year recovery is superior to -15% with 8-year recovery
- 4.Pair with Risk-Adjusted Metrics: Combine drawdown analysis with Sharpe/Sortino for complete picture
Investor Takeaway
Maximum drawdown reveals the true psychological and financial cost of volatility. It's one thing to accept 15% standard deviation in theory; it's another to watch your investment fall 40% and hold through the pain. Always stress test your emotional capacity to endure drawdowns before committing capital.
Where to Find This on Our Site
See Maximum Drawdown analysis on our Research & Market Insights page, featuring:
- Risk metrics and drawdown analysis by asset class
- Historical performance during market downturns
- Capital preservation and downside risk analysis
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